Tyco: Breaking Up and Taking Off

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Cleaning Up on Tyco's Breakup by Jonathan R. Laing

Highlighted companies: Tyco International Limited (TYC)
Summary: Many were burned by Tyco International (TYC) when the stock collapsed after revelations its then-CEO and CFO had looted $170 million. New reasons for Wall St.’s pessimism include the stock’s flat-lining over the last year and the fact that the plan to split the unwieldy conglomerate into three units through spinoffs of its health-care business, electronics unit, and fire-and-security and engineered-products-and-services operations did not create much buzz. C. Steven Tusa of JPMorgan: "Perhaps the most favorable thing one can say about Tyco is that most everybody is pessimistic about the company." But T. Rowe Price Capital's (TROW) Appreciation Fund has been quietly amassing Tyco shares, and according to T. Rowe's co-manager Jeff Arricale, when one considers the potential values of the three new companies, there is plenty of reason for optimism. He sees them trading at a combined $38-45/share:

• T. Rowe Price has high hopes for Tyco's soon-to-be liberated electronics business, which last year generated $12.7 billion in revenues and $1.8 billion in operating income. The electronics business figures to benefit in the years ahead from both the surge in the penetration of electronic devices in new cars and a strong global economy. TROW analyst Peter Bates thinks the unit is worth $12-14/share.
• In Tyco's crown jewel, its health-care operation, revenue growth has slipped to just 2% in the fourth fiscal quarter and operating margins have dropped from 26%+ a few years ago to just 22.8% in Q3 2006. While many say these developments indicate that significant underinvestment in new products is starting to exact a toll, Bates argues that the situation is hardly irreparable for the unit, and doesn't see the need for increased R&D as proving too punishing. Strong Q4 revenues in Asia-Pacific (+14%) and Latin America (+13%) bode well for the unit's global sales. And its top-notch sales group allows it to quickly translate acquisitions of promising new technologies into sales gains. Bates has the health unit trading for $15-$17 a share.
• Tyco's fire-and-security unit has about 200 plants worldwide that make pipes, valves and flow-control equipment for Tyco's fire-safety systems, and commercial/governmental users. Many of these will be shut down and consolidated to increase the unit's scale and lower fixed costs, boosting margins. Bates sees the unit trading for $11-$14 a share.

Barron's Bottom Line: "Shareholders may hit the trifecta: Shares could be worth 50% more than Tyco's current stock, thanks to higher price-earnings ratios."
Related: Tyco Q4 Profits Soar 38% to $1.27 Billion, Looking Beyond the Scandal at Tyco, Tyco 10-K: Kozlowski Delinquent In Restitution Payments